If the world’s most powerful central bank is going to continue to flood its economy with liquidity – even if inflation starts to rise – then it’s usually a signal to buy shares and sell bonds.

If other central banks do the same then surely it’s game on.

But what if the actions of central banks is also interfering with financial markets, making them inefficient rather than efficient?

A host of traders are blaming interventions in currency, credit and sovereign bond markets for producing jumpy markets that are becoming very difficult to trade.

If spreads on corporate bonds or currencies widen, then it becomes more expensive for companies to issue and hedge their debt or foreign exchange risk. The Australian dollar has always been one of the most traded currencies in the world and, lately, central banks everywhere have been piling into $A denominated assets.

But eventually that trend will be reversed.

Hedge funds in particular are finding it tough in these sorts of markets but given they have been branded killer hedgehogs in the past – think Malaysian prime minister Mahathir Mohamad, who blamed them for the Asian currency crisis and labelled ringgit-selling by George Soros a crime – they are unlikely to get much sympathy.

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But what politicians and central banks say and do is having more effect on financial markets than economic fundamentals. Eventually that must change. Sharemarkets were on the back foot yesterday for the second straight session amid more disappointing news from the US reporting season.

The S&P 500 is still up a very healthy 12 per cent this year, but that’s more on the back of central bank stimulus rather than profits and growth.

Debts, deficits and imbalances in Europe, and elsewhere, are playing a huge role in markets but it’s true central banks have never been far from the action.

In the past, former chairman of the US Federal Reserve,
Alan Greenspan
, was always on hand with his famous “put’’ to right any wrong.

Everyone seemed to be on that trade and there were very few complaints.

But these days traders are trying to make money in a much less liquid environment, with fewer instruments to trade. Interest rates are at record lows, so making money there seems to be coming to an end.

Banks also need to stump up more capital and that could increase the cost of trading. Any extra cost the banks are hit with will surely be passed on to customers.

Over the past few years, trading income has also added substantially to the bottom line of the four major banks. For example, the crisis has led to opportunities in government bonds as the budget went into deficit. If trading becomes tougher, it becomes tougher to replicate those profits.

The US Fed’s balance sheet has expanded 221 per cent over the past five years, up from $US800 billion in 2007 to $US2.85 trillion.

At the same time, the European Central Bank’s balance sheet has grown to €3046 billion ($3852 billion) from €1500 billion, while assets at the Bank of England have grown to £407,839 million ($633,363 million) from £102,241 million.

At some stage that will all have to be wound back, but there is the possibility that, until the world’s central banks achieve their aims, interest rates may simply stay low. Many investors have grown up in an era when interest rates changed rapidly, but there have been relatively long periods of low interest rates.

In this atmosphere, bond prices may not move that much and returns may simply represent most bonds’ coupon rate. But there’s always an unexpected twist in markets.